Why you should give Vedanta open offer a miss

In an attempt to increase stake in Vedanta, the parent company Vedanta Resource, has come up with an open offer to buy 17 per cent of the floating shares at ₹235 per share, which is about 6 per cent higher than the current market price of ₹222. The offer opens on March 23 and closes on April 7. The current open offer has been revised from the previous ₹160 per share for 37.17 crore shares (10 per cent) announced in January 2021.

This follows a failed delisting attempt in October 2020, for which the company proposed to acquire all fully paid-up equity shares of the company that are held by public shareholders at an indicative offer price of ₹87.5 per share.

Though the current offer price looks like a better deal compared to the earlier offers, it doesn’t appear attractive enough given the upturn in the commodities cycle and the earnings visibility of the group.

Also, at the offer price of ₹235 per share, Vedanta trades at 8.43 times its trailing 12-month (TTM) earnings. Note that the TTM earnings considered here are before considering the exceptional items – mainly impairment of oil & gas assets in Q4 2020. The valuation at the offer price is slightly below its historical three-year average of 9.54 times for the period ended January 31, 2020 (after which pandemic impact hit Indian stock markets).

Having said that, high debt levels of the parent, Vedanta Resources, and its dependence on Vedanta to repay its obligations is considered a key overhang for the stock. Also, the stock can be volatile given nature of commodities business. Thus, investors with high-risk appetite can continue holding the share.

Commodity cycle

The performance of Vedanta is highly dependent on the prospects of base metals and the oil and gas sectors. In the nine months period ended December 2020, the company derived revenue from zinc (almost 30 per cent), oil and gas (8 per ent), aluminium (34 per cent), copper (12 per cent) and others.

The base metal prices have been on an upswing, touching multi-year highs on the back of strengthening Chinese economy, cheap liquidity and buoyant sentiment across about vaccines.

In the last one year, the LME prices of aluminium, zinc and copper went up by 38 per cent ($2,188 per tonne now), 51 per cent ($2,787 per tonne) and 92 per cent ($9,036 per tonne), respectively.

Crude oil prices also are gradually moving up from the start of November and are now at the pre-Covid levels aided by voluntary production cuts by OPEC plus.

Going ahead , with accommodative fiscal policies and improvement in economic activity (especially China), anchored by the vaccination drive across the globe, the prospects for both base metals and oil and gas sectors looks attractive globally.

With the government’s push to Atmanirbhar Bharat and the infrastructure activities in the domestic economy, the demand for base metals is expected to be good, at least in the near future.

The current favourable conditions, both in terms of prices and demand for the base metals and oil and gas products, bode well for Vedanta.

The YTD growth capex of the company has been about ₹ 350 million as on January 29, 2021. Clearly, it is significantly short of full year guidance of ₹600 million. The management, however, assures that this is not at the cost of volume growth.

Improving operating performance

In the nine-month period December 2020, the company’s consolidated revenues were down by 8 per cent (y-o-y), largely due to the impact of Covid-19 on the first few months of the fiscal. However, the operating profit during the same period went up by 34 per cent (y-o-y) on the back of fall in input cost during the period and gradual increase in realisations in the third quarter of the fiscal.

The EBITDA (earnings before interest, taxes, depreciation and amortisation) from Zinc India (Hindustan Zinc), the most profitable subsidiary of the group, stood at ₹7,774 crore (+14 per cent y-o-y) during the 9MFY21, with margin close to 40 per cent. This was better with the cost of production falling from $1,065 per tonne last year to $958 per tonne. The management aspires to reach $900/tonne in the near term.

The aluminium business has seen a significant turnaround in the current fiscal on the back of lower cost of prodiuction and improved production mix. The EBITDA from the segment during the said period was at ₹5,033 crore as against ₹861 crore reported in the last year. The cost of production of aluminium recorded in the third quarter at $1,315 per tonne, down 26 per cent (y-o-y) , and the lowest in the last five years.

During the nine-month period in FY21, the oil & gas business got impacted due to the fall in crude oil prices. For the nine-month period in the fiscal FY21, the operating profit stood at ₹ 2,137 crore as against ₹ 6,402 crore a year ago.

The net debt to EBITDA has also gone up to 1.5 times from 1.2 in the September 2020 quarter and one time a year ago. This was owing to the large cash outflow during the quarter, towards dividend and inter-company loan to promoter entity. Though the management assures there wouldn’t be any increase in the inter-corporate loans to the parent going ahead, any increase further (if any) will exert pressure on Vedanta that could have an impact on the capex.